In this episode of the Industries in Motion podcast, Greg Pardy, Managing Director and Head of Global Energy Research, Robert Kwan, Managing Director and Canadian Energy Infrastructure Analyst, and Andre-Philippe Hardy, Head of Canadian & Asia-Pacific Research at RBC Capital Markets, discuss the Canadian government’s Trans Mountain Pipeline Expansion (TMX), which is slated to be in service during the first quarter of 2024. We expect this pipeline expansion to transform Canada’s oil egress and give oil sands producers in Canada greater export access to global markets, including Asia.

(cheerful music)

- Welcome to the Industries In Motion Podcast

from RBC Capital Markets

where we will be exploring what's new and what's next

in today's fast moving markets and industries.

My name is Andre Hardy

and I'm Head of Canadian and Asia Pacific Research.

Please listen to the end of this podcast

for important disclaimers.

Now let's get into today's episode.

I'm very happy to introduce our two guests

Greg Pardy and Robert Kwan.

Greg is a Managing Director

and Head of Global Energy Research at RBC Capital Markets.

He helps lead a team of more than 30 professionals

in Canada, the United States, Europe and Australia

who cover energy and utilities companies.

He is also directly responsible

for research coverage of Canada's senior oil companies.

Greg joined RBC Capital Markets in 2009

and has about 30 years of equity research experience.

He consistently ranks as a top Canadian energy analyst

in independent investor servings.

Robert is a Managing Director

and Energy Infrastructure Analyst at RBC Capital Markets

primarily covering Canadian midstream companies.

Robert joined RBC in 1998 in investment banking

and joined the Energy Infrastructure Research team in 2003.

He has been the lead analyst

for our Canadian Pipelines, Power

and Utilities team since 2007,

which has been consistently top ranked

in Independent Investor Servants.

Today we'll be discussing the Canadian government's

Trans Mountain Pipeline Expansion or TMX,

which is slated to be in service

during the first quarter of 2024.

We expect this pipeline expansion

to transform Canada's oil egress

and give oil sand producers in Canada

greater export access to global markets including Asia.

So Greg, to start, why is this

590,000 barrels per day Trans Mountain Expansion

a big deal for Canada?

And when is it expected to be completed?

- Thanks, Andre.

The Trans Mountain Pipeline's

been in operation for about 70 years.

And it's the only major Canadian pipeline

transporting oil to the West Coast.

And just to be clear,

it runs from Edmonton, Alberta to Burnaby, BC.

As a made in Canada solution,

this expansion of the Trans Mountain Pipeline

will bring its nominal capacity up to 890,000 barrels a day,

and that would be versus about 300,000 barrels a day

where it sits today.

Trans Mountain expects that expansion

to be mechanically complete by the end of 2023

and then in service during the first quarter of 2024.

And as you mentioned, this is important.

It will give, you know,

oil producers in Canada more optionality

to diversify their oil exports globally.

And just to put that into context,

about 97% of Canada's net oil exports

went to the US in 2022, but there's more to it than that.

As long as I can remember,

the Achilles heel for oil producers in Canada

has been the inability to ship

all of their product out of the country

on export pipelines and achieve global prices.

We saw this drama play out again and again over the years.

The reason TMX is so important is that

for the first time, in my memory at least,

Western Canada will have excess export pipeline capacity

that we peg at about two to 300,000 barrels a day

once the expansion is in service next year.

And we don't expect that space to be filled until 2026.

So that is very good news for oil prices

in Western Canada which we'll come back to later.

- Thanks, Greg.

That's really helpful context.

Robert, TMX has experienced

some significant cost escalations since it was approved.

Can you explain that to us?

- Yes, it definitely has, Andre,

at $30.9 billion Canadian.

TMX has seen its cost balloon from 7.4 billion

when the project was approved back in 2019.

This reflects schedule delays and cost overruns

related to inflationary and supply chain pressures,

severe flooding in British Columbia, the pandemic,

as well as community consultation costs.

- Thanks.

We're talking here about

fairly significant capacity expansion.

Do you expect Trans Mountain to run

at full capacity once it comes on?

- Trans Mountain is a contracted pipeline

and shippers have signed long-term agreements

covering 80% of the pipeline's capacity.

So it's taker pay nature and high fixed toll component

of the contract creates a sunk cost for shippers.

It is possible that the 20%,

and that's about 178,000 barrels per day,

and that 20% spot capacity

that's been reserved on Trans Mountain

for uncontracted shippers may not be fully utilized.

- And then what happens

to Enbridge's mainline pipeline once TMX is on?

- Yeah, the mainline is an uncontracted

common carrier pipeline.

We expect producers to shift barrels largely

off of that system and onto Trans Mountain

based on shippers as contractual commitments

as we just talked about.

We expect mainline volumes could fall about 200,000

to 300,000 barrels a day when TMX is fully in service

with that capacity slowly filling back up over time.

- And what's the proposed toll associated

with the use of a pipeline following completion of TMX?

And what are some important considerations

you'd associate with that?

- Yeah.

In June, 2023, Trans Mountain filed interim tolls

to reflect the flow through of the escalation

of certain expansion capital costs.

The Trans Mountain spot toll likely makes

some shipping routes uneconomic,

which benefits the competing pipelines.

The recently filed interim toll for the roughly 20%

of Trans Mountain's uncontracted capacity

is approximately $13.50 per barrel for heavy oil

which maps to about $10 US per barrel.

That toll though is subject

to Canada Energy Regulator approval

and that process is ongoing.

At this level, we believe the cost of shipping spot barrels

down Trans Mountain plus the tanker cost

and the Panama Canal expense to put those barrels

into the US Gulf Coast

now it makes this route uneconomic

versus competing pipeline routes

such as the Keystone Pipeline system,

as well as the Enbridge mainline

onto the Flanagan South pipeline

and then seaway into the Gulf Coast.

- So on that topic, Greg,

what is the cost to ship a barrel of oil

on an Aframax old tanker these days?

- Aframax tanker freight costs

are volatile in the daily rate.

But directionally we understand that it would cost

about 90 cents US, so call it a dollar a barrel,

to move a barrel from Burnaby into Long Beach, California,

somewhere in the neighborhood of 3.50 to $4 US per barrel

from Burnaby into China,

and then 6 1/2 to $7 US per barrel from Burnaby into India.

- So how big of a deal is Trans Mountain's

higher toll for Canadian oil producers?

- Yeah, this is not trivial by any stretch.

The higher Trans Mountain toll

which is applied to all Trans Mountain barrels then,

it just serves to erode the net back,

the margin on these barrels

as they seek export markets, including Asia.

- So should a higher Trans Mountain toll

impact the price of Canadian oil?

Like how are you thinking

about the spread between Western Canada Select

or WCSS and the WTI oil prices?

- Yeah, we have had to really think through that.

And I think where we've landed is,

the toll is just not gonna be the determining factor

just given the low variable cost

that's around 95 cents a barrel Canadian,

which should be a greater driver

of producer decision making.

In our minds it's far more important that Western Canada

will move into a period of excess export pipeline, you know,

takeaway capacity next year once TMX is in service.

And again, we don't expect that excess pipeline space

to be filled until 2026.

Now, this is a bit technical,

but structurally the TMX,

the expansion of TMX then should serve

to dampen volatility and compress

what we refer to as geographical or location spreads.

But remember WCS, WTI spreads that is comparing

a heavy sour barrel, which is WCS,

to a light sweet barrel, which is WTI.

So the light-heavy spread matters

and will be impacted by OPEC plus output policy decisions

amongst other factors.

- And on that topic,

why were WCS, WTI spreads so tight back in June?

- Yeah, a bit of a perfect storm and lots of reasons.

But I'd say, China's voracious appetite

for heavy barrels coming out of its zero COVID policy,

oil sands maintenance and supply limitations elsewhere,

shut-ins, you know due to Alberta's wildfires,

relatively low commercial oil inventories in Western Canada

and negligible apportionment on the mainline

were all factors.

WCS spreads have widened out recently

as supply has returned to the market.

- So, sticking with you, Greg,

we spoke earlier about the Trans Mountain expansion,

improving the ability for Canadian oil sands producers

to export to global markets.

Where will Canadian heavy oil barrels go once TMX is online?

And are the Canadian oil sands growing much?

- Yeah, the majority of Trans Mountain's

current 300,000 barrels a day capacity,

let's just start there, is exported into PADD 5 in the US,

so mainly to Washington State.

About two thirds of those exports

are going into Washington State.

We just under call it,

30,000 barrels a day or 10% exported to California.

But once TMX is online

we expect additional oil sands barrels to penetrate Asia

but more importantly, California.

And as those barrels move into California,

we expect to see some displacement of waterborne imports.

And you know, the question you're asking

is also very important.

I mean, the short answer with respect to oil sands growth is

we don't expect very much over the next several years.

And in fact, we peg oil sands growth from 2022

to 2027 to grow at a compound annual growth rate of just 2%.

Now that reflects a couple of things.

The first is just decarbonization initiatives

and a lack of social license to grow

high GHG emissions barrels.

And the second one is something we've really seen

resonate in the energy sector,

which has been shareholder preferences for distributions,

i.e, dividends and buybacks, versus production growth.

- Thanks, Greg.

Going back to the Trans Mountain Pipeline expansion, Robert,

you've published that we're waiting

for the for sale sign to go up.

Can you talk us through that

and who might ultimately buy it?

- Yeah. Thanks, Andre.

So timing wise,

Trans Mountain expects the expansion

to be operational in early 2024.

Although absent,

potentially significant contingent payments,

we assume potential buyers will need to see

the pipeline's tolls finalized

by the Canada Energy regulator,

which could be several months

after the expansion is placed into service,

particularly given current shipper concerns

with the interim tolls.

Now ultimately, we expect an indigenous led consortium

to acquire the project.

That being said, due to the likely size of the transaction,

we believe the number of strategic parties

that could be involved will be very limited

with only Pembina

in our Canadian midstream coverage universe

publicly expressing an interest

via its Chinook Pathways partnership

with the Western Indigenous Pipeline Group.

We also see the potential for interest

from financial players,

whether in partnership with indigenous communities and,

or joining an existing consortium such as Chinook Pathways.

- Well, Greg and Robert, thank you very much for your time.

This has been really informative

and the Trans Mountain expansion

will certainly transform Canada's oil egress picture

when it comes online.

So what else lies ahead in today's

ever evolving markets and industries?

We'll be keeping track right here on Industries in Motion.

Thank you for joining us

on this episode recorded on August 2nd, 2023.

Please make sure you subscribe to Industries in Motion

wherever you listen to your podcast.

And if you'd like to continue the conversation

or if you're interested in more information,

please contact your RBC representative directly

or visit our website at www.rbccmm.com.

Thank you very much.

(cheerful music)

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